Mixed signals follow India’s testy tax declarations

After first-half debt and equity-market rallies on buoyant foreign-investment inflows, with the MSCI index up 20%, Indian officials tried to calm nerves around the new national goods and services tax (GST), suggesting the launch would not be a repeat of the erratic demonetization process upending the economy and the banking system.

Prime Minister Narendra Modi, marking three years in power, came out of the Group of 20 summit with praise for commercial initiatives even though his country is still 130th, or in the bottom one-third, on the World Bank’s “Doing Business” ranking. The multilateral Financial Stability Board in turn noted broad compliance with Basel III capital and liquidity standards, while the central bank’s own annual stability reports flagged banking-system deterioration.

A Harvard University study placed India ahead of China for economic, financial and technology sophistication over the next decade, and helped to neutralize a critical cover story in The Economist magazine saying that reforms to date were mainly “small” and would not lift long-term living standards and attack poverty.

With these mixed narratives, fund-manager focus has been on underlying fundamentals, with slower 6-7% growth, rising state-government budget deficits with farmer loan relief, and single-digit credit expansion on skittish supply and demand, which combine to erode the past year’s market-darling run.

The first-quarter 6% growth figure may not improve over the full fiscal year, with industrial output increasing only 1.7% in the 12 months to May, below the 2% consensus forecast. Demonetization’s cash crunch hit manufacturing with a lag, and also suppressed inflation, with the core reading outside food and energy down to 4%.

The July GST rollout, presented as “good and simple” with the administration’s penchant for popular branding, is widely viewed by the business community as another example of immediate economic pain for unknown medium-term gain. The framework encompasses six categories, from essential to luxury items, at progressive rates from 0-28%, with multiple distinctions within each band, such as for meals in air-conditioned or sidewalk restaurants.

It is designed to reduce the hundreds of hours spent annually on paying taxes and to raise collection among the lowest ratios in big emerging markets, but the government backed off its initial calculation of a 2% advance in gross domestic product due to simplification.

The opposition Congress party, which first proposed the tax-reform push more than a decade ago, has refused to back the GST, citing confusion and the potential regressive impact on agriculture from levies on fertilizer and equipment.

Gold imports tripled in June as consumers bought bullion and jewelry in advance of the new tax regime to lock in savings.

The tax schedule is more than 200 pages long, and companies with nationwide operations will have to file an estimated 1,000 digital returns. Small firms will absorb automation and reporting costs after reeling from the banknote confiscation, and they have appealed separately to states for forbearance and special help.

The relationships between the state and central governments pose a major hurdle to fiscal goals even though the prime minister’s Bharatiya Janata Party (BJP) is in charge across jurisdictions after the latest elections. Revenue is to be transferred from Delhi to provincial seats, as they are on their own spending binge, taking average deficits toward 3.5% of GDP.

Farm credit waivers win votes, but have also battered state bond ratings, and Modi has shown little inclination to rein them in, while also sympathizing with Hindu fundamentalist policies such as cattle-slaughter bans, which have provoked violence against meat-industry workers.

Debt forgiveness will further compromise bank balance sheets, with the non-performing ratio in gross terms close to one-tenth of total loans and worsening, according to the central bank’s end-June update. Under a “severe” macro shock, capital adequacy would also fall below 9% for a half-dozen institutions, with dominant public-sector banks in poor shape with bad loans at three-quarters of net worth.

The central bank also warned of cyberattacks and fraud after account information for millions of credit-card users was breached, as a similar deliberate technical glitch may have briefly halted National Stock Exchange trading recently.

The Reserve Bank is pressing individual workouts for big infrastructure-project borrowers like Essar Steel, which recently sold assets to a Russian counterpart, but has shied away from sweeping moves like central agency disposal, which could burnish bold vision credentials to mesmerize foreign investors further.

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